Investors often ask us whether they should invest through Roth IRAs or Traditional IRAs. As we discussed in Prioritizing Retirement Account Contributions, we generally favor deductibility. And we certainly favor capturing employer matching and profit sharing. But sometimes, IRA contributions are not deductible. In certain cases, we prefer Roth IRAs to Traditional IRAs. In this blog we describe three of the most common scenarios when Roth IRAs are superior to Traditional IRAs.
Before we look at those scenarios, we want to point out that the IRS prohibits high income savers from contributing to Roth IRAs. In 2019, Roth contributions begin to be reduced when Adjusted Gross Income (AGI) reaches $193,000 for married couples filing jointly ($122,000 for single filers). They are fully phased out above $203,000 ($137,000 single).
Deductibility is also key. Roth contributions may never be deducted from taxable income. However, Roth IRA owners may take qualified distributions completely free of tax. If you’re not covered by a company retirement plan, contributions to a Traditional IRA are deductible. On the other hand, if you have a retirement plan at work contributions to Traditional IRAs may not be fully deductible. For married couples with company retirement plans, and AGIs below $103,000 ($64,000 single), Traditional IRA contributions are deductible. It’s worth noting that deductibility phases out by $123,000 ($74,000).
3 Times when Roths Win
- When you are unable to deduct Traditional IRA contributions. Married filers with income between $123,000 and $203,000 earn too much to deduct Traditional IRA contributions, yet they may still contribute to Roths. In this scenario, we typically recommend tax free growth from a Roth over tax-deferred growth from a Traditional IRA.
- When your current income is almost certainly lower than future income. An easy example is the medical student or resident, who is able to save aggressively now and expects to have high income in retirement. In 2019, the marginal income tax rate for single filers with income up to $82,500 is 22%. As a physician, their top rate could certainly exceed 35% or even 37% in later years.
- When you have earned income after age 70 ½. Traditional IRA holders must take Required Minimum Distributions beginning in the year they turn 70 ½. For this reason, the IRS prohibits further contributions. In contrast, you can contribute to a Roth IRA if you have earned income and are over the RMD age. An individual expecting to work well into her later years might contribute to a Roth IRA and enjoy the benefit of maximizing tax-free accumulation.
A Reminder About Timing
Whether Roth or Traditional, retirement contributions for tax year 2018 can be made until Monday, April 15, 2019. Please consult your tax advisor for specific recommendations.